Retiring at 60 with a DB anchor and a DC pot
Mrs Folake Balogun (58) plans to retire at 60. She has a defined-contribution pot of ₦42m, a defined-benefit pension of ₦1.8m a year from age 60 (inflation-linked), and a state pension of ₦1.2m a year from 65. Her mortgage costs ₦1.8m a year until age 65; other living costs are ₦5.4m a year. She has ₦3m in cash and a low risk tolerance. Her adviser estimates annuity rates at about 6% at 60 and 6.8% at 65, and a balanced portfolio could support a 4% initial withdrawal. Folake wants to stop work at 60, keep her home, and leave something to her two adult children. She is wary of locking all her pot into an annuity because her mother lived to 94. She asks whether she can afford to retire at 60 and whether a drawdown plan is safer than an annuity.
1. Calculate Folake's income shortfall at 60 and assess affordability under the annuity and 4% drawdown options.
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Income need
Living costs ₦5.4m + mortgage ₦1.8m = ₦7.2m a year until age 65. After 65 the mortgage ends and the state pension starts, so the need is ₦5.4m − ₦1.2m = ₦4.2m a year from the DC/DB sources.
Shortfall at 60
DB pension ₦1.8m is secure. The shortfall is ₦7.2m − ₦1.8m = ₦5.4m a year for the first five years. From 65 the shortfall falls to ₦4.2m before any DC income.
Annuity option
₦42m × 6% = ₦2.52m a year. Total income at 60 = ₦1.8m + ₦2.52m = ₦4.32m, leaving a shortfall of ₦2.88m until 65 and ₦1.68m after the state pension starts.
4% drawdown option
₦42m × 4% = ₦1.68m a year. Total income = ₦3.48m, leaving a shortfall of ₦3.72m until 65 and ₦2.52m after 65. The ₦3m cash could bridge part of the gap but would be exhausted quickly.
Conclusion
She cannot afford to retire at 60 on the current plan without cutting expenditure, working part-time, downsizing or using capital faster than is prudent. The mortgage alone consumes ₦1.8m a year. A 4% withdrawal is not a safe withdrawal guarantee; it is an initial planning rate, and her low risk tolerance and longevity expectations make it fragile.
2. Compare annuity and drawdown for Folake, including sequence-of-returns risk and inflation.
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Annuity
- Advantages: guaranteed income for life, mortality credit, no investment decisions, protects against living to 94.
- Disadvantages: irreversible, no flexibility, inflation protection costs extra, limited death benefits unless a guarantee or spouse's pension is bought, and the quoted rate may fall before purchase.
- Fit: suited to covering essential spending, but buying at 60 locks in a 6% rate when deferring to 65 gives an estimated 6.8% and five more years of contributions.
Drawdown
- Advantages: flexible income, keeps the pot invested, potential legacy, can vary withdrawals.
- Disadvantages: she bears investment risk and longevity risk; a poor early return can permanently reduce sustainable income (sequence-of-returns risk); low risk tolerance may lead to cash-heavy returns that lag inflation.
- Inflation: a level annuity loses purchasing power. A drawdown portfolio must generate enough return to cover withdrawals and inflation.
Judgement
A blended approach is better than an all-or-nothing choice. Use the secure DB pension as the inflation-linked core. Bridge the 60–65 period with part-time work, the ₦3m cash and limited withdrawals. At 65, consider using enough of the pot to buy an inflation-linked annuity covering the essential shortfall, keeping the remainder in drawdown for flexibility and legacy. Do not buy a single-life level annuity without checking her health, dependants and death-benefit needs.
3. What phased-retirement actions would you recommend between 58 and 65?
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- Close the 60–65 gap before stopping work. Target additional savings or part-time income of at least ₦2m–₦3m a year for the transition. Working to 63, even part-time, reduces the required withdrawal and protects the pot from sequence risk.
- Use cash deliberately. Keep at least two years of net spending needs in cash or short-dated deposits. Do not use all ₦3m to repay the mortgage if it leaves no liquidity; compare the mortgage rate with safe deposit rates.
- Maximise pension contributions while working. Check employer contributions and tax relief. Review the DC pot's charges, fund choices and default glidepath; a low-risk tolerance does not justify holding only cash inside the pension.
- Set a withdrawal policy. Do not withdraw 4% automatically. Set a ceiling, review annually and use guardrails. If the pot falls by more than 10% in real terms, reduce discretionary withdrawals.
- Plan the annuity purchase. Obtain quotes at 60 and 65, disclose health and lifestyle factors, and consider a deferred or partial annuity. Check whether the DB scheme offers a tax-free lump sum and compare its commutation rate.
- Review estate plans. Drawdown pots may be inherited, but tax treatment depends on the scheme and beneficiaries. Update nominations and consider whether a dependant's pension is needed.